What are the forces moving the Minnesota economy? Adam Belz tries to identify the trends and show the connections between Minnesota and the larger U.S. and global economies. You can connect with him on Twitter: @adambelz

Minneapolis Fed president: Keep rates down until unemployment falls below 5.5%

Posted by: Adam Belz under Business trends, Economics Updated: September 20, 2012 - 3:50 PM

Narayana Kocherlakota is putting numbers on it.

The president of the Federal Reserve Bank of Minneapolis said Thursday the Fed should keep interest rates extremely low until unemployment reaches 5.5 percent.

So long as inflation doesn’t rise above 2.25 percent, Kocherlakota said, the Federal Open Market Committee should promise to keep rates low until unemployment falls below the 5.5 percent target.

“As long as the FOMC satisfies its price stability mandate, it should keep the fed funds rate extraordinarily low until the unemployment rate has fallen below 5.5 percent,” Kocherlakota said in a speech at Gogebic Community College in Ironwood, Mich. – a two hour drive east of Duluth.

Kocherlakota does not serve on the FOMC, though like Fed bank presidents, he attends the meetings.

The speech builds on the decision last week by the Fed to do a third round of quantitative easing, an effort to further dridown interest rates by buying long-term securities from banks. Fed Chairman Ben Bernanke said the central bank will work to keep interest rates low “for a considerable time after the economic recovery strengthens.”

That phrase was important to economists and investors, because they interpreted it as an open-ended commitment to low interest rates, which are supposed to encourage lending and stimulate the economy.

Kocherlakota took it a step further on Thursday. He argued that if the public believes the Fed will start raising interest rates when unemployment falls below 7 percent, or even below 6 percent, people will be more reluctant to spend and the economy will recover more slowly.

He made a psychological argument: The lower the explicit target for unemployment, the longer the Fed will keep interest rates low, and the more comfortable people will be spending money. That, in turn, should help the economy recover faster, he said.

“The FOMC can provide more current stimulus if people believe that liftoff will be triggered by a lower unemployment rate,” Kocherlakota said.

Kocherlakota’s “liftoff plan” in part reflects the ideas of Chicago Fed president Charles Evans, who has advocated a similar plan.

The Ninth District of the Federal Reserve, of which Kocherlakota is president, covers Montana, North and South Dakota, Minnesota, northern Wisconsin, and the Upper Peninsula of Michigan.

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